Heterogeneous Beliefs about Rare Event Risk in the Lucas Orchard

59 Pages Posted: 23 Apr 2014 Last revised: 18 Feb 2017

See all articles by Ilaria Piatti

Ilaria Piatti

University of Oxford - Said Business School

Date Written: September 18, 2015


This paper investigates the asset pricing implications of investor disagreement about the likelihood of a systematic disaster. I specify a general equilibrium model with multiple trees and heterogeneous beliefs about rare event risk, to understand how risk-sharing mechanisms affect equity and variance risk premia, at an aggregate level and in the cross-section of stock returns. I identify a state-dependent link between equity and variance premia, that changes with the distribution of agent consumption. Empirically, as in the model, the variance premium's predictive power for future excess returns is greater during times of financial distress, mainly for small stocks.

Keywords: Heterogeneous beliefs, Systemic disasters, Lucas orchard, Variance risk premium, Correlation risk premium, Predictability

JEL Classification: G12, C22, C24, D80

Suggested Citation

Piatti, Ilaria, Heterogeneous Beliefs about Rare Event Risk in the Lucas Orchard (September 18, 2015). Paris December 2014 Finance Meeting EUROFIDAI - AFFI Paper; Saïd Business School WP 2014-5. Available at SSRN: https://ssrn.com/abstract=2427628 or http://dx.doi.org/10.2139/ssrn.2427628

Ilaria Piatti (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

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